EU Banks: Resilient, but Not Untouchable

Margins Under Pressure, But Europe’s Banks Hold Firm

European banks have entered a more nuanced phase of the cycle. While 2024 was marked by record profitability driven by high interest rates and market volatility, 2025 brings a more complex backdrop: declining rates, geopolitical risks, and shifting capital rules. According to Morningstar DBRS, Q1 earnings remained solid despite a notable decline in net interest income (NII), thanks to strong performance in fee-based income and reduced loan loss provisions—particularly in Southern Europe.

Net Interest Income Down, But Not Out

As Morningstar DBRS highlights, Q1 2025 saw a retreat in NII across much of the European banking sector—particularly in countries like Portugal, Greece, and the Nordics, where variable-rate lending dominates. This reflects the impact of rate cuts by central banks. UK banks were a notable exception, aided by structural hedges that are now paying off as the yield curve normalizes.

Despite this drag, total earnings remained robust. Banks benefitted from rising noninterest income, fueled by trading revenues, asset management performance, and higher customer activity. In Spain, noninterest income jumped 20% year-over-year; in the Nordics, by 5%.

Costs Rising, But Under Control

Operating expenses increased for most banks, driven by wage inflation and investments in technology, particularly artificial intelligence. However, these cost pressures were partially offset by reduced regulatory levies—especially as the Single Resolution Fund hit its target level and required no contributions in 2025. Italian and German banks stood out for maintaining stable or declining costs through disciplined cost control.

Credit Quality Remains Strong

Asset quality continues to be a bright spot. Stage 3 loans (nonperforming) declined further, particularly in Southern Europe. Loan loss reserves dropped accordingly, leading to lower cost of risk. Even in markets that previously showed slight NPL upticks—like Germany, the Netherlands, and the Nordics—metrics remained solid.

However, the report cautions that uncertainty around U.S. tariffs and geopolitical events, especially in the Middle East, could weigh on capital markets and economic confidence. That said, Morningstar DBRS considers the overall impact on asset quality manageable due to European banks' geographic diversification and limited direct exposure to affected regions.

Capital Ratios Declining Gradually

While Common Equity Tier 1 (CET1) ratios remain high, they are beginning to decline. As Morningstar DBRS explains, this is due to:

• The implementation of final Basel III rules.

• Banks optimizing their capital buffers amid greater regulatory clarity.

• Ongoing M&A activity absorbing capital.

In many jurisdictions, particularly the Netherlands, banks have already absorbed the full regulatory impact. In others, the effects are expected to spread over time.

M&A on the Rise

Consolidation is clearly gaining momentum. Italy remains a key hub for deal-making, but activity has expanded to Portugal, Greece, Poland, and Romania. The acquisition of Novo Banco by France’s Groupe BPCE exemplifies the trend toward geographic and business-line diversification—especially into areas like asset management and insurance.

Still, the landscape for cross-border deals remains challenging, with fragmented regulatory regimes and political resistance acting as barriers. DBRS warns that some ongoing transactions may not materialize due to these frictions.

Conclusion: A Sector in Transition

Morningstar DBRS maintains a stable outlook for European banking, with positive trends in 26% of its rated universe. While net interest income faces pressure, diversified revenue streams and strong asset quality have helped maintain solid profitability in Q1 2025.

The path forward is marked by cautious optimism. Tailwinds from strong fee income and declining loan loss provisions may fade, and pressures from rates, geopolitics, and M&A dynamics could challenge resilience.

Yet for now, Europe’s banks appear well-positioned. Their ability to adapt to a lower-rate, higher-volatility world will define the next chapter in a sector that is no stranger to transformation.

Entering Italian NPE Market is a Newsletter and a Linkedin Group focused on News, Updates, and Insights on Italian Banks, Distressed Credit Markets, Fintech, and Real Estate.

Relevant Links:

https://dbrs.morningstar.com/research/456646/european-banking-earnings-trends-and-outlook-amid-global-trade-tensions

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